Luxury Stocks: We’re Far From a Cliff

by Charles Sizemore | September 28, 2012 8:00 am

It has been my view for several months that fears of a Chinese slowdown are overstated with respect to their effect on luxury sales, and that luxury stocks are one good news release away from enjoying a monster rally. Still, if investors are fleeing the sector, we don’t want to be left holding the bag. So for now, we sift through earnings releases looking for clues.

We did get some good news from fashion powerhouse Prada, which said in its recent press conference that it had had no significant slowdown and that it expected mid-year earnings to be nearly 60% higher year-over-year.

“The numbers were quite good up to the first three weeks of September,” CEO Patrizio Bertelli said, “but we don’t want to push our luck. It’s common sense to be cautious right now.”

Well said, and I would have to agree.

Elsewhere, the story is mixed. Burberry (PINK:BURBY[1]) disappointed in its last release[2] … yet Hermes (PINK:HESAF[3]) actually raised its full-year estimates. It’s hard to draw firm conclusions from any of this, but it is safe to say that demand for luxury goods is far from falling off a cliff.

Moving a few steps down the prestige ladder, Sizemore Investment Letter recommendation Coach (NYSE:COH[4]) continues to be a roller-coaster ride. In the past six weeks Coach has seen its share price soar from below $50 to $63, only to fall back down to $54. Those are the kinds of price swings that will give you indigestion, but such is the market we’re in.

Moving on, our luxury auto play Daimler (PINK:DDAIF[5]) warned that “profits at its Mercedes-Benz car unit would not reach the level of last year because of deteriorating market conditions in Europe and intensifying competition in the Chinese market.”

Profits from car sales in the second half of the year would trail the first half. This followed a similar announcement from Porsche.

These announcements do not particularly worry me because bearishness is already so intense in the global auto sector that the downside from here should be modest and the upside — should we get any encouraging news — is enormous.

Daimler trades for just 7 times earnings and a laughable 0.38 times sales. It also pays a handsome 5.73% dividend. When you’re buying a stock of Daimler’s quality this cheap, a few bumps in the road shouldn’t bother you. I expect very strong returns from Daimler in the year ahead, even if sales continue to be lackluster.

Finally, our luxury booze conglomerate Diageo (NYSE:DEO[6]) continues to be a strong performer. The stock recently hit a new 52-week high, and we are up over 66% in less than two years.

Diageo recently was featured in a Barron’s article[7]. The stodgy old purveyor of Johnnie Walker scotch whisky and many, many other brands has embraced celebrity endorsement from prominent rap stars, most notably “Diddy” (formerly known alternatively as “Puff Daddy,” “P. Diddy” and his actual birth name, Sean Combs). As Barron’s writes:

“The rap-booze hookup has profited both sides. Diddy’s multiyear deal to push Ciroc, dubbed one of the few vodkas made from grapes, could be worth up to $100 million to the music mogul. With 1.3 million cases sold last year, it was the No. 1 celebrity brand. Its producer, Diageo, says Ciroc sales jumped 62% in the fiscal year ended June 30.”

I’m not the biggest fan of luxury vodkas for the simple reason that preferences here can be fickle (you’re depending on rap star endorsements, for crying out loud). I’d glad to see that Diageo is making it work, but in my view the more attractive product lines are the company’s standard scotch brands[8], for which demand in the West is stable and demand in emerging markets is spreading like wildfire.

Along those lines, the Financial Times reported this morning that Diageo might be on the cusp of a major new expansion into India:

“The worsening financial woes of Vijay Mallya, the Indian drinks baron, are pushing him closer to selling a strategic stake in his whisky business to Diageo, the world’s biggest distiller. Mr Mallya’s United Spirits and Diageo, which is aggressively expanding in emerging markets, on Tuesday confirmed they were back in talks”

United Spirits controls nearly 60% of the Indian booze market, so the appeal to Diageo is easy enough to understand.

In any event, Diageo remains one of my favorite ways to get backdoor exposure to emerging markets, and even after its recent run-up I consider it a long-term buy.

Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter, and the chief investment officer of investments firm Sizemore Capital Management. Sign up for a FREE copy of his new special report: “Top 3 ETFs for Dividend-Hungry Investors.”[9]